A Big Company Recovery?

After the release of the 2009 fourth-quarter GDP estimate, some forecasters are now predicting a rapid recovery in 2010. Certainly, the fourth-quarter growth rate was impressive, particularly following the modest pickup reflected in the third-quarter results and the terrible results of the previous several quarters. Implicitly, these optimistic forecasts are based on the assumption that the United States economy has been fundamentally unchanged by the recession.

I suppose an assumption that the economy has been fundamentally changed in a good way could motivate a positive forecast, but I’ve not seen anyone make that argument. If someone does, I’d like the chance to debate them. We certainly haven’t addressed the too-big-to-fail problem, the bank health issue, or Fed-induced moral hazard problem created by Greenspan’s repeated easing in response to market declines.

On the other hand, we are promised increased regulation for many sectors and higher taxes. I’d like to know which sectors, besides legal and accounting perhaps, were the winners, and how they are poised for imminent booms.

If the economy is unchanged, we would expect to see economic growth in small businesses, and a recovery in real estate markets and construction. I don’t see how that happens. I have a hard time seeing how the flow of capital to small businesses can be restored soon, and imagining a near-term robust real-estate and construction recovery is even harder, while foreclosures are still climbing and homeownership rates still high.

Given these facts, most forecasts these days are, unsurprisingly, more modest. Forecasts of tepid economic growth with slow job gains are typical. Some are more pessimistic, anticipating a new slowdown brought about by increasing taxes or new financial crises.

Certainly, the United States faces continued economic challenges. When one looks more closely at the past-two-quarter’s GDP estimates, it is difficult not to conclude that they were elevated by temporary factors, such as home-buying incentives, auto buying incentives, and inventory changes.

Other data compel one to even less sanguine conclusions. Bank charge-offs, driven by weak real estate markets and weak economic activity, are still climbing, hitting new records every quarter. Jobs are still being lost, albeit at slower rates than those disastrous rates we saw in 2009’s first half. Residential foreclosures are still climbing. Many commercial real estate markets appear to be collapsing. Normalized TED spreads, the cost of an incremental increase in risk, are still high, implying continued risk aversion among market participants.

The human costs of this recession have been even greater. About 15 million Americans are unemployed, over half of whom have been unemployed for 19 weeks. That doesn’t include the almost-five-million discouraged workers who have left the job market, or the over-nine million who are underemployed, involuntarily working at jobs below their capabilities or part time.

The employment numbers are sobering, but they don’t do justice to the personal costs those without gainful work are enduring. The average unemployment duration is now about 30 weeks. Many of our new workers and long-term unemployed will never see their careers recover. Instead, they will toil at jobs below their abilities, earning lower salaries than would have been the case without the recession.

For the rest of us, these workers represent underutilized human capital, perhaps even a financial burden. They imply slower long-term economic growth and suggest our economy has undergone a fundamental change.

The magnitude and duration of unemployment are not the only changes we’ve seen. It appears that, for the next decade at least, the potential growth of small business has changed, for the worse.

Many of our banks are essentially zombies, existing, but incapable of serving an economic purpose, and I see no initiative to fix the banks. Small businesses need financial intermediation to grow. They cannot grow without an active and vigorous banking sector. Big business, with its direct access to capital markets, does not need financial intermediation. It can grow without an active and vigorous banking sector.

Big business also operates, if it is big enough, with a free insurance policy against failure. Some big businesses are not big enough to be considered too big to fail, but many of them are large enough to attract or lobby for subsidies or government protection.

Small businesses, on the other hand, are on their own. No one insures or subsidizes small business. Few even notice when a small business fails.

Big businesses are also likely to benefit from an increased regulatory environment. Proportionately, the compliance burden is far less for larger businesses than small businesses. Regulation often serves as a tax on entrepreneurs, but a boon for big company bureaucrats.

Yet we cannot expect big business to rescue or re-invent the economy since they have little stake in pushing the envelope on innovation. Big businesses tend to be bureaucratic and risk averse. They do not innovate.

However, small businesses are key to economic innovation and growth. There is a reason that the computer business is dominated by relatively young firms such as Microsoft and Google, instead of IBM. There is a reason that the old, protected, United States automobile companies couldn’t compete when the younger and more nimble, Japanese manufacturers entered the market with the higher-quality and more fuel efficient products.

If the balance between large and small companies has been changed, fundamentally and at least semi-permanently, we are in big trouble. As our small firms are being stymied, the fundamental potential United States economic growth rate has shifted down, and the “natural” unemployment rate has shifted up. That is, we can expect slower growth and higher unemployment that we have become accustomed to in the past-unless somehow economic policy again favors entrepreneurs over corporate and government bureaucracies.

Bill Watkins is a professor at California Lutheran University and runs the Center for Economic Research and Forecasting, which can be found at clucerf.org.

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